Dedicated Legal Support For Emerging Growth Companies
For business entities to qualify as emerging growth companies, they must meet specific requirements to keep their EGC status. However, because business performance and profitability are only sometimes consistent or linear, it can be challenging to know whether or not your emerging growth company meets the appropriate rules and requirements under the Securities Act.
Anthony L.G., PLLC, can help you keep up to date on these rules and requirements, and our team can assist you in making changes when necessary.
What Is An Emerging Growth Company (EGC)?
Title I of the JOBS Act, initially enacted on April 5, 2012, created a new category of issuer called an “emerging growth company” (EGC). An EGC has total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year. It first sold equity in a registered offering after Dec. 8, 2011. An EGC loses its EGC status on the earlier of (i) the last day of the fiscal year in which it exceeds $1,070,000,000 in revenues; (ii) the last day of the fiscal year following the fifth year after its IPO (for example, if the issuer has a Dec. 31 fiscal year-end and sells equity securities according to an effective registration statement on Nov. 2, 2012, it will cease to be an EGC on Dec. 31, 2017); (iii) the date on which it has issued more than $1,070,000,000 in non-convertible debt during the prior three-year period; or (iv) the date it becomes a large accelerated filer (i.e., its non-affiliated public float is valued at $700 million or more).
What Are The Benefits Of An EGC?
The primary benefits of an EGC include scaled-down disclosure requirements both in an IPO and periodic reporting, relief from the auditor attestation requirements in Section 404(b) of the Sarbanes-Oxley Act, confidential filings of registration statements, certain test-the-waters rights in IPOs, and ease on analyst communications and reports during the EGC IPO process.
Since the passage of the JOBS Act, the FAST Act has provided additional benefits to an EGC, including the omission of certain historical financial statements in registration statements, an advantage that the Securities and Exchange Commission (SEC) has now extended to all companies. Moreover, the ability to file confidential registration statements has also been expanded to include all companies.
Many but not all of the benefits available to an EGC are also available to a smaller reporting company. For a summary of the scaled disclosure public to an EGC and the differences in disclosure requirements between an EGC and a smaller reporting company.
EGCs And The Five-Year Rule
The first emerging growth companies will begin losing EGC status as the fifth anniversary of the creation of an EGC has now passed. Those companies that will lose status due to the passage of time are almost unilaterally not pleased with the impending change and concurrent increase in regulatory compliance.
Can An EGC Qualify As AN SRC?
A company that exits EGC status and does not qualify as a smaller reporting company will either be a non-accelerated filer, accelerated filer, or large accelerated filer with concurrent disclosure requirements.
Under Section 404(a) of the Sarbanes-Oxley Act, companies are required to include in their annual reports on Form 10-K a statement of management on the company’s internal control over financial reporting (ICFR) that:
States management’s responsibility for establishing and maintaining the internal control structure.
Includes management’s assessment of the effectiveness of the ICFR. Section 404(b) requires the independent auditor to attest to and report on management’s judgment. To review, information on, and certify to management’s ICFR, an auditor must, in essence, independently audit the ICFR.
A shortage of information and guidance is available on an auditor’s duties under Section 404(b), including PCAOB Auditing Standard No. 5. Although many estimates exist, based on a high-level review, there is some consensus that the average annual cost of Section 404(b) compliance for a company with a public float between $75 and $250 million is more than $250,000 and sometimes much higher.
At a meeting of the SEC Advisory Committee on Small and Emerging Companies (Advisory Committee) on Sept. 13, 2017, an executive of a biotechnology company that is losing EGC status and will not qualify as a smaller reporting company pled for relief. Of all the changes his company will face, the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act loom large.
Sutro Biopharma CEO William Newell gave a presentation to the Advisory Committee advocating for the increase in the definition of a smaller reporting company, as proposed, but also continuing to exempt smaller reporting companies from Section 404(b) compliance. Sutro is pre-revenue, as are many biopharma companies. Companies that are pre-revenue but may have a sizeable public float must comply with Section 404(b) with funds that would otherwise get used for growth, including increased staffing.
Also, Sutro is private and cites burdensome compliance costs as a deterrent to accessing public markets. The SEC has publicly talked about the need to energize the U.S. IPO market, including in a speech by Chair Jay Clayton and one by Commissioner Michael Piwowar.
There is some hope for these companies. The current SEC administration supports capital-raising efforts and decreases unnecessary regulation for large and small companies. The pending Financial Choice Act would increase the threshold for compliance with Section 404(b) for companies with a public float of $500 million or more. The SEC Government-Business Forum on Small Business Capital Formation encourages the change to the definition of a smaller reporting company and the increase in the threshold for compliance with Section 404(b).
Differences Between EGCs And SRC Disclosure Requirements
The scaled-down disclosures for smaller reporting companies and emerging growth companies include, among other items:
- Only three years of business description as opposed to 5.
- Two years of financial statements as opposed to 3.
- Eliminate certain line-item disclosures, such as graphs and selected financial data.
- Relief from the 404(b) auditor attestation requirements.
However, although similar, there are differences between the scaled disclosure requirements for an emerging growth company vs. a smaller reporting company. In particular, the following chart summarizes these differences:
|Scaled Disclosure Requirement||Emerging Growth Company||Smaller Reporting Company|
|Audited Financial Statements Required||
|Description of Business (Item 101)||Standard disclosure requirements apply.||
|Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters (Item 201)||Standard disclosure requirements apply.||You are not required to provide the stock performance graph.|
|Selected Financial Data (Item 301)||You are not required to present selected financial data for any period before the earliest audited period given in the initial registration statement.||It is not required.|
|Supplementary Financial Data (Item 302)||Not required until after IPO.||It is not required.|
|MD&A (Item 303)||May limit discussion to those years for which audited financial statements are included.||
|Quantitative and Qualitative Disclosures about Market Risk (Item 305)||Standard disclosure requirements apply.||Not required, but related disclosure may be necessary for MD&A.|
|Extended Transition for Complying with New or Revised Accounting Standards||
||Standard disclosure requirements apply.|
|Internal Control over Financial Reporting (Item 308)||
||Non-accelerated filers, including SRCs, are not required to provide an attestation report of the registered public accounting firm.|
|Executive Compensation Disclosure (Item 402)||
|Scaled Disclosure Requirement||Emerging Growth Company||Smaller Reporting Company|
|Certain Relationships and Related Party Transactions (Item 404)||Standard disclosure requirements apply.||
|Corporate Governance (Item 407)||Standard disclosure requirements apply.||
|Risk Factors (Item 503(c))||Standard disclosure requirements apply.||It is not required in periodic reports.|
|Required for the same number of years, it discloses selected financial data.||It is not required.|
Need Assistance Navigating The Rules? We Can Help.
Keeping up with the stiff requirements and regulatory environment surrounding EGCs can be challenging to handle alone. Our attorneys have years of experience helping EGCs navigate these challenges and can serve as practical guides. Call 877-541-3263 or visit our contact page to schedule an initial consultation.